I . , United States General Accounting Ofl’ice f//Pa 7 6 GAO Testimony For Release Savings and Loan Crisis: Federal Response to on Delivery Fraud in Financial Institutions Expected at 10:00 a.m. EDT August 1, 1990 Statement of Richard L. Fogel Assistant Comptroller General General Government Programs Before the Committee on Banking, Housing and Urban Affairs United States Senate GAO/T-GGD-90-61 GAO Fono 160 (12/87) ‘ Savings and Loan Crisis: Federal Response to Fraud In Financial Institutions SUMMARYOF STATEMENT BY RICHARD L. FOGEL ASSISTANT COMPTROLLERGENERAL U.S. GENERAL ACCOUNTING OFFICE GAO estimates that losses from thrift failures could be as much as $500 billion in the next 40 years. Though the extent to which fraud contributed to or caused thrift and bank failures is not known, fraud has played a significant role. Our review to date indicates that the Justice Department and other federal agencies have been actively pursuing this fraud. U.S. attorneys, for example, are in the process of prosecuting thousands of financial institutions' officers, directors, major borrowers, accounting firms, law firms, and others. The number of successful prosecutions is growing. Furthermore, on its own initiative and in response to congressional action, Justice is stepping up its efforts by adding and redeploying resources to concentrate more on financial institution fraud. Initiatives recently announced by Justice and the financial regulatory agencies are promising. New task forces are being established. Priority lists have been developed. A Special Counsel for Financial Institution Fraud has been appointed in Justice. It is too early to tell what impact these actions will have. Moreover, GAO's assessment raises some concerns. One concern is that, although Justice is focusing more systematically on financial institution fraud, it may not be giving sufficient attention to two areas: -- Justice lacks a mechanism that would allow the newly appointed Special Counsel for Financial Institution Fraud to readily access the key information needed to determine how well the efforts are proceeding, what more needs to be done, where it needs to be done, and what further resources are actually needed. -- Justice and the agencies referring instances of suspected fraud need to ensure that their newly expanded coordination initiatives are actually leading to the concentration of resources on top priority targets and in determining the best way to proceed against these targets. GAO is also concerned that the number, magnitude, and complexity of fraud cases may demand further infusion of resources. The Congre& should continue to monitor new initiatives and require Justice to report regularly on the results achieved. Congress could then better assess the investigative and prosecutorial resources needed and the effectiveness of interagency coordination for this critical effort. Mr. Chairman and Members of the Committee: We are. pleased to participate in your hearing on the federal response to fraud in depository institutions. As you requested, my testimony today will cover (1) what we have learned about the extent of fraud in failed and open depository institutions; (2) what the federal response has been to the fraud, including recent Justice Department initiatives: and (3) our assessment of the response to fraud in depository institutions as we see it today. EXTENT OF FRAUD IN FAILED AND OPEN DEPOSITORY INSTITUTIONS During the last 4 l/2 years, 831 banks and 515 thrifts have failed and have been resolved. Another 247 thrifts were in the Resolution Trust Corporation's (RTC) conservatorship program as of June 30, 1990. These failures have been attributed to economic problems; deregulation of the thrift industry and inadequate supervision: poor management in the institutions: and fraudulent activities on the part of officers, directors, borrowers, accounting and law firms, and others associated with the depository institutions. Many of these same factors threaten the solvency of many open institutions and will probably result in additional failures. P No one knows exactly how great the role of fraud has been in the failure of thrifts and banks, nor the extent to which it is occurring in open institutions. RTC suspects that fraud or criminal activity on the part of directors, officers, or senior managers contributed to the failure of 40 percent of the thrifts . it has investigated. Ely and Co., savings and loan consultants, have offered a rough estimate that 3 percent, or $5 billion of the $147 billion in thrift losses have been caused by Wcrooks." The Federal Deposit Insurance Cooperation (FDIC) estimates that fraud on the part of directors, officers, or senior managers contributed to 13 to 18 percent of bank failures. One of the difficulties with estimating the extent of fraud in depository institutions is determining if and when suspect activities crossed the fine line between poor business judgment and fraud. Financial institution fraud cases typically involve complex transactions that must be thoroughly investigated. Investigators and prosecutors often must sift through thousands of documents just to determine whether a criminal offense has occurred. Thus, these investigations are labor intensive and a great deal of time (sometimes several years) is required to complete a thorough investigation and obtain an indictment. The more creative criminals are in covering the "paper trail" of their crimes, the more arduous this task becomes. Also, prosecutors are faced with the task of proving that the paper trail establishes beyond a reasonable doubt that a criminal violation was committed and that the accused was guilty. 2 FEDERAL RESPONSE: BASELINE ACTIVITY LEVELS The federal bank and thrift regulators--FDIC, the Office of the Comptroller of the Currency (OCC), the Federal Reserve System, and the Office of Thrift Supervision (OTS)--are the federal government's first line of defense against illegal activities and/or wrongdoing associated with banks and thrifts. The regulators are responsible for examining and supervising banks and thrifts to ensure that they are operating in a safe and sound manner and in compliance with applicable laws and regulations. The nature of the institution's charter determines which regulatory agency has federal oversight responsibility for the institution. RTC also plays a role in identifying fraud and wrongdoing in failed thrifts. FDIC and RTC are authorized to initiate civil suits in instances where improper conduct of professionals associated with failed institutions is uncovered. The agencies are responsible for investigating all failed institutions to determine the merit of pursuing civil professional liability suits. As of July, 1990, FDIC and RTC were involved in about 500 civil professional liability suits, which include actions against directors, officers, other professionals, and their insurers, as well as interventions in shareholder actions. In instances where criminal activities are suspected, the regulators and the financial institutions they regulate are to refer . these activities to the FBI for investigation and to a U.S. attorney for possible prosecution. These referrals are submitted on a standardized criminal referral form. The regulatory agencies use different criteria for keeping records on the criminal referrals they and the institutions make, so we could not get an accurate count of the number of referrals. Nevertheless, we found that: -- OTS logs all referral forms. OTS logs showed 5,014 referrals in 1989 and 2,785 through June 1990. -- The Federal Reserve System logs referrals by individual suspects as opposed to the number of referral forms. They logged referrals on 3,239 individuals in 1989 and 1,445 individuals through June 30, 1990. -- OCC logs referral forms involving an estimated loss of over $200,000, a bank insider, or some other significant circumstance. CCC logs showed 824 referrals in 1989 and 637 referrals through June 30, 1990. -- FDIC logs referral forms involving estimated losses exceeding $10,000 or a bank director, officer, or principal shaieholder. FDIC logs showed 938 referrals in 1989 and about 798 referrals through July 11, 1990. -- The RTC system for maintaining criminal referral data is not yet operational. RTC estimates that it has submitted about 200I referral forms since August 1989. Within the Justice Department, the FBI investigates and U.S. attorneys prosecute those criminal referrals having merit. The FBI also begins investigations based on information from other sources (informants and other members of the public). The FBI headquarters tracks all investigations field offices have underway, but there is no accounting for the criminal referral forms received. In October of this year the FBI plans to begin keeping a record of each referral and providing feedback to the regulatory agencies on any action taken. The FBI had 7,097 financial institution fraud investigations underway as of February 1990. Of the investigations underway as of February 1990, 3,027 were major investigations involving potential dollar losses of $100,000 or more. Further, of the major investigations, 2,278 involved banks (276 were failed banks), 654 involved thrifts (234 were failed thrifts), and 95 involved credit unions (20 were failed credit unions). FBI field offices determined through a manual search that as of Februaiy 1990, they had 21,147 criminal referrals relating to financial institution fraud on file that the FBI calls 5 "unaddressed referrals." Unaddressed referrals (1) may not meet the U.S.